OPINION:
There’s new interest in indexing the capital gains tax to account for inflation. This is something good for everyone that conservatives have been pushing for years. The White House is working now to determine whether the president has the legal authority to make this change in tax policy by his own hand. There’s evidence that he can.
One key pro-growth feature of the Ronald Reagan tax cuts in 1981 was the provision to index federal income tax brackets for inflation. This meant that no longer would middle-class investors be victimized as in the “bracket creep” of the ’70s, where and when taxpayers were swept into higher tax brackets even when the gain in income was due only to inflation.
The Gipper declared that it wasn’t fair to require taxpayers to pay higher taxes just because of inflation. That’s generally recognized as a good-tax principle to live by, and since the 1980s most features of the federal tax code protect for inflation. Most states have made these changes in their state tax codes, too.
But there’s one glaring exception to the federal rule, and that’s the way capital gains are taxed on the sale of a stock, a business or other property. Anybody, economist or not, can see, that a dollar today isn’t worth the dollar of 10, 20 or 30 years ago.
In unusual cases shareholders must pay capital gains taxes on assets held for a long term, even when the “gain” was due purely to inflation. In other cases, shareholders must pay a capital gains tax on assets that actually lose money due to inflation. Such cases are relatively rare.
One advocate in the White House for capital gains indexing is the vice president. As a member of the House of Representatives a decade ago, Mike Pence introduced legislation to index capital gains for assets held for more than three years. Larry Kudlow, the new chairman of the National Economic Council, wrote last year that “without the federal tax on inflationary gains, asset prices will adjust until they reach a new, higher equilibrium. Shareholders and other investors will see their portfolios grow. And the federal government will collect billions of dollars in new tax revenue as taxpayers realize real capital gains.”
Indexing capital gains for inflation will further reward shareholders for holding onto their stocks and will discourage the kind of “short-termism” and day trading that liberals like Hillary Clinton complained about when she was running for president. “Short-termism” it may have been, but Mrs. Clinton made a tidy fortune in the highly volatile cattle-futures when she was the wife of the governor of Arkansas. Working with a friendly broker who “assigned” profits to his day-trader clients, Mrs. Clinton turned a thousand-dollar investment into $100,000 in just 10 months. (One scholar of very high math estimated that if Hillary had continued to profit at this rate for 10 years she would have been a “virgintillionaire,” which is dozens of zeroes beyond a billionaire.)
But would the president have the legal authority to make this capital-gains adjustment with an executive action? To do so, he would ask the U.S. Treasury Department to issue new regulations that would define a “gain” after inflation. Congress has never specifically mandated that a “gain” must be determined in nominal terms.
The George H.W. Bush administration asked the Justice Department to look into whether he had such authority to act on his own like that, but the department lawyers never did. One analysis, by Charles Cooper and Vincent Colatriano in the Harvard Journal of Law & Public Policy, suggests however that “the Treasury has regulatory authority to index capital gains for inflation.”
If Mr. Trump decides to issue the relevant order, the courts, and ultimately the U.S. Supreme Court, would decide. If Messrs. Cooper and Colatriano are correct, the White House would have struck a mighty blow for liberty and tax fairness.
One middle ground position would be to index all future capital gains for inflation, perhaps beginning on June 1, 2018. This would make stocks more valuable and increase share prices. This would further encourage more patient investment in long-term projects with potential high future gains. That’s the essence of risk taking.
If Mr. Trump’s constitutional lawyers can make this legal argument for this level-headed policy change, now is the time to do it.
Please read our comment policy before commenting.